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What’s the difference between economics and finance?

Posted on: May 24, 2022

Economics and finance are disciplines that are interrelated but are not the same. They are both concerned with the world of money, markets, and transactions but are very different in how they approach them. So what are the main differences and how can you discern which area you want to specialise in?

What is economics?

Economics looks at regional and global economies or markets and analyses the behaviour of people within these markets and economies. Questions that an economist may ask themselves include:

  • What are people buying?
  • Why are they buying it?
  • Where are they buying it from?

The answers to these questions help economists understand current trends in supply and demand, and why the economy as a whole is behaving in the way that it is. For example, house prices are dictated by demand and are affected by interest rates, which has a knock-on effect on the economy. Governments rely on economists to formulate economic strategies that predict changes in spending and how these changes impact policies and other legislation.

The two primary areas of economics are macroeconomics and microeconomics. Macroeconomics aims to decode the collective behaviour of individual actors and how that plays a part in shaping aggregate economic outcomes. Microeconomics studies the behaviour of these individual actors such as consumers and individual business entities.

Economics is a broader field of study than finance requiring a solid grounding in mathematics, including linear algebra and calculus, as well as econometrics and statistics. Economists use mathematical modelling to understand behavioural influences on decision-making and other key influencing factors such as altruism and habit formation. Behavioural economics is a separate interdisciplinary field within microeconomics that considers the psychological, social, and cognitive aspects of individual decision-making.

What are consumer theory and producer theory?

Consumer theory is a branch of microeconomics that studies household behaviour. Utility function is the key formula in consumer theory that measures welfare or satisfaction based on the consumption of certain goods. However, consumers are limited by budget constraint, which in turn limits the kinds of goods and services they’re able to purchase. In economics, consumers are utility maximisers, meaning that they will purchase the optimal number of goods, such as food or clothing, that maximises their satisfaction or welfare, according to their budget. Utility function is used in rational choice theory to analyse human behaviour.

Producer theory is the branch of microeconomics that deals with the behaviour of business entities. Business entities turn inputs like capital, labour, and land, into outputs. Prices and availability of inputs such as raw materials dictate production capacity. Producer theory is the supply to consumer theory’s demand. The aim of any business entity is to produce the amount of output that maximises profits based on its inputs.

Industrial organisation has grown into its own field within microeconomics. It focuses on studying the structure of business entities and how they operate in different markets. Labour economics is another field which studies interactions between workers and business entities within the labour market.

What is finance?

Finance as a subject refers to the financial management of banks, companies, governments, and the assets of individuals. Financial experts focus on resources, capital, and revenue, helping clients to identify investment opportunities that maximise their funds. They also advise on risk management, long-term wealth management, and projections for potential growth. The three main areas of finance are public finance, corporate finance, and personal finance.

Public finance

This area is concerned with how a government pays for the services it provides for the public. It includes public spending, taxes, budgets, and debt management, which come under fiscal policy.

Government spending is financed by taxation and borrowing from banks, insurance companies and other nations. Governments have a responsibility to provide welfare and benefits for tax paying citizens and to maintain a stable economy so that people can save money securely.

Corporate finance

Corporate finance refers to the financial management of companies and corporations. Companies tend to have their own finance departments to handle their financial reporting but may also refer to a consultancy with investment banking knowledge when, for example, considering a stock offering.

Start-ups often seek out venture capital from angel investors in exchange for a percentage of ownership. If the start-up goes on to perform well financially, an initial public offering (IPO) means the shares in the company are made available on a stock exchange. These kinds of agreements require financial expertise in corporate finance.

Personal finance

Financial strategies for personal finance rely on the individual’s earning, living requirements, goals, and desires. These can vary wildly from high-net-worth individuals to independent business owners to those looking to buy their first home, for example.

Good personal finance advice involves recommendations on a pension or savings for retirement, responsible use of credit cards and loans, suitable insurance policies, and securing the best mortgage rates.

What are financial services?

The financial services sector is crucial to the health of the economy because it ensures the free flow of capital and liquidity in the marketplace. When the economy is strong, consumer confidence and purchasing power surge. When the financial services sector flounders, it impacts the economy and can lead to a recession.

The sector includes banks, investment companies, finance companies, insurance companies, lenders, accounting services, and property brokers. Financial services are tasks such as the investment advice and management of assets a financial advisor provides for a client. They are not the same as financial goods, which are products that include mortgages, stocks and shares, and insurance policies.

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